Rights Issue

What is a Rights Issue?

A rights issue is an opportunity for existing shareholders to buy more new shares in the company. This type of issue provides existing shareholders with securities known as rights. 

The shareholder can use the rights to purchase new shares at a discount to the current price on a specified future date. By this method, a company allows its shareholders to increase their exposure to the stock at a reduced price.

Shareholders may start trading the rights on the market the same way they would trade ordinary shares until the date the new shares can be purchased. 

The rights granted to a shareholder have monetary value, compensating current shareholders for the future dilution of the value of their existing shares. 

Dilution occurs when a company’s net profit spreads across a larger number of shares through a right offering. As a result of the dilution, a company’s earnings per share decreases.

A prospectus or prospectus supplement is commonly used to sell it. In comparison to other more dilutive financing options, it may be especially useful for all publicly traded companies. 

Companies generally opt for it to minimize dilution and maximize the useful life of tax loss carryforwards because equity issues are generally preferable to debt issues from the company's perspective.

How Rights Issues Work

The work can be explained better with the help of an example. Suppose a person holds 2000 shares in a company worth $6 each. The company is in financial trouble and is looking to raise money to fulfill its debt obligations. 

The company finally decided to launch new shares to raise $40 million by issuing 10 million shares for $4 each. The company decided the issue to be a three-for-10 issue. This means that for every 10 shares held, a shareholder will get 3 shares at a discounted price of $4.

A shareholder has three options with a rights issue.

1. Fully accepting the rights to purchase

To fully benefit from it, the shareholder will spend $4 on each share of the company they are entitled to purchase under the issue. 

The person can buy 600 shares, as the issue is three-for-10, and he holds 2000 shares at the discounted price of $4 for a total of $2400. 

After the rights issue is completed, the market price of the company's shares will not be the same as $6 as the new shares are issued at a discounted price of $4.

The price of a share after the rights issue is called ex-rights share price, and a simple calculation can estimate it. This price can be found by dividing the price paid to own the shares by the total number of shares owned. 

Here, the price paid for the existing shares is 2000 * $6 = $12,000, and for the new shares it is 600 * $4 = $2,400. So, the total price paid comes out to be $14,400. 

The total number of shares held is 2600. Therefore, the ex-rights can be calculated as $14,400 /2,600 = $5.54. 

2. Neglecting the Issue

If the shareholder doesn't have $2,400 to buy the additional 600 shares at $4 each, they can always let their rights lapse. However, this is not normally advised. 

If one does nothing, their shareholding will be diluted due to the additional shares issued by the company.

3. Other Investors can purchase the rights

Rights are not always transferable. These are referred to as non-renounceable rights. However, in most cases, the rights allow individuals to choose whether to exercise the option to purchase the shares or sell their rights to other investors or the underwriter. 

Renounceable rights are rights that can be traded. The rights are known as nil-paid rights after they have been traded.

Features of a Rights Issue

The Right Issue of Shares is a proper invitation to the Company's existing shareholders to purchase additional new shares. This term refers to the right granted to current shareholders to purchase new shares at a lower price than the market price. 

The primary goal of the Right Issue of Shares is to ensure an equitable distribution of shares to the Company's shareholders while having no effect on the shareholders' existing voting rights.

The Company conducts the right issue of shares to increase the market exposure of its shareholders. Following are some of its main features: 

1. Companies issue rights when they need money for a variety of reasons. The procedure allows the company to raise funds without paying underwriting fees.

2. Existing shareholders are given preferential treatment in a rights issue, in which they are given the right to buy shares at a lower price on or before a specified date.

3. Existing shareholders have the right to trade with other market participants until the new shares are available for purchase. The rights are traded in the same way that regular equity shares are.

4. The number of additional shares that shareholders can purchase is usually proportional to their existing shareholding.

5. Existing shareholders can ignore the rights; however, if they do not purchase additional shares, their existing shareholding will be diluted following the issuance of additional shares.

6. Any shareholder who wishes to subscribe to the offered shares must also have their shares converted into a dematerialized form.

7. Only the company's shareholders have the authority to issue the right shares.

Reasons for a Rights Issue

Suppose a company raises funds through a follow-on public offer. In that case, it must go through a lengthy process that includes getting merchant bankers to price the issue, offering document approval from authorities, etc. Furthermore, numerous fees must be paid.

It is the quickest and most cost-effective way for a company to raise capital. The company saves money on expenses such as underwriting fees, promotional costs, and so on that it would have racked up in any other type of fundraising.

In addition, unlike any other equity fundraising method, the promoter's holding in this issue is not diluted. Promoters commit to fully subscribing to their part of the rights and the undersubscribed portion.

Rights generally need less regulatory approval for existing shareholders, who are already well aware of the company.

A large amount of capital may be required when a company plans to expand its operations. Instead of debt, they may prefer equity to avoid fixed interest payments. It may be a more efficient way of raising equity capital.

Companies seeking to improve their debt-to-equity ratio or purchase a new company may seek funding through the same channel. Troubled companies may issue shares to pay off a debt to improve their financial health.

When debt or loan funding is unavailable, suitable, or affordable for a project, a company usually raises capital through a rights issue.

Example of a Rights Issue

Rights offers are priced at a market discount, and allotment is guaranteed. Existing shareholders may be uninterested if the rights are provided close to the current market price.

A company decides the proportion to offer rights shares based on the amount of money it wants to raise and at what price. For example, a company decided to raise $2.5 billion at a price of $10 per share when the market price of the share was $14. 

It decided to issue one share for every 14 shares held by an existing shareholder.

Although the number of shares to be allotted to a person is fixed or guaranteed, they can also apply for more shares. The right shares are tradable on the markets for a limited time and traded with a unique ticker name.

Suppose the company’s rights are trading at $4.6; then a right holder would buy the shares at $4.6 + $10 = $14.6, whereas the current market price of the original shares is $14.

Applying for more shares than the rights allows individuals to buy more if a few investors decide not to subscribe, either because they ignored or missed the announcements or didn't want to.

Rights Entitlement (RE)

A company that launches a rights issue will issue rights entitlement (RE) to shareholders. REs are distributed in the same ratio to shareholders as on the record date as part of the new shares.

When a person sells a RE, he gives up his rights in favor of someone else. The buyer of the RE acquires the right to purchase the shares. Obtaining RE shares does not imply obtaining rights shares. An investor must apply for rights shares based on separate entitlements. 

RE is a temporary credit of shares in the Demat account that allows rights holders who do not want to add more shares of the same company to sell their RE shares on exchanges for a price to other willing investors.

Previously, shareholders who did not wish to apply had to forgo their RE. The renunciation process was complicated and required the buyer and seller to sign on paper. However, with the exchange process, things are much easier - just a tap on the broker's platform, and it's sold. 

The issuance of RE shares allows shareholders to profit from their RE shares.

Partly Paid Shares

When a company raises capital from shareholders, it issues shares that represent the shareholder's ownership stake in the company. These shares can be paid in full or in part. 

In the case of fully paid shares, the company receives the entire amount at once, whereas in the case of partially paid shares, the money is collected in installments. 

The latter option does not necessitate raising the entire amount all at once. Furthermore, it gives shareholders time to pay for their shares. Investors who purchase partially paid shares have the opportunity to purchase a company's stock at a lower price. 

However, they must pay the remaining installments on time. Once all installments on these shares have been paid, they are translated into fully paid shares and traded at the same price.

The company can decide how much should be paid at each installment and when the installments should be paid.

Partially paid shares are available for purchase and sale on stock exchanges like fully paid shares. 

Their price is determined by the company's fully paid stock price, the amount of the installment paid, the approximate time remaining to pay the remainder, the stock's volatility, and demand-supply. 

The issuance price or base price is the portion of the money paid in the case of partially paid shares.

Suppose a company issues right shares at $15 per share, and the current market price per share is $20. It decides to pay the first installment of $3.75. The remaining amount is $11.25. 

The partially paid shares are listed on the exchanges at $9, whereas their ideal listing price should have been $8.75 ( $20 - $11.25 = $8.75). The shade higher listing price depicts the partially paid shares' higher volatility.

Conclusion

Companies use rights issues as a tactical financial strategy to raise capital from current shareholders by giving them the chance to buy more shares at a lower price.

Using this technique, corporations can strengthen their financial position without paying high underwriting fees or unduly reducing the voting rights of current shareholders.

Companies can quickly get much-needed capital through a rights issue, particularly during difficult financial times or when starting ambitious expansion plans.

Companies want to encourage current investors to keep or grow their ownership in the business by providing them with the opportunity to buy new shares at a reduced price. This helps to boost shareholder confidence.

Furthermore, rights issues give businesses the opportunity to reduce fixed interest payments connected with debt financing, improve their financial health, and optimize their debt-to-equity ratio while pursuing development ambitions.

Likewise, the introduction of partially paid shares and rights entitlement (RE) gives shareholders more freedom to manage their investments and take advantage of market possibilities.

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